Tax Benefits of Owning an Oil Well

Congress has enacted several tax credits in relation to oil or natural gas production.

The enhanced oil recovery credit: is applied to certain project costs incurred to enhance a well’s oil or natural gas production. This credit is up to 15% of the costs incurred to enhance production.

Small Producers Tax Exemption: The 1990 Tax Act provided some special tax advantages for small companies and individuals. This tax incentive, known as the "Percentage Depletion Allowance", is specifically intended to encourage participation in oil and gas drilling. The "Small Producers Exemption" allows 15% of the Gross Income from an oil and gas producing property to be tax-free.

Active vs. Passive Income: The Tax Reform Act of 1986 introduced into the Tax Code the concepts of "Passive" income and "Active" income. The tax code specifies that a working interest (as opposed to a royalty interest) in an oil and gas well is not considered to be a passive activity. This means that all net losses are active income incurred in conjunction with well-head production and can be offset against other forms of income, such as wages, interest, capital gains, etc. See IRS publication 925 Passive Activity and At-Risk Rule.

Lease Costs: These include the purchase of lease and mineral rights, lease operating costs, and all administrative, legal and accounting expenses. These expenses are 100% deductible in the year they are incurred through cost depletion.